REAL ESTATE GUEST BLOGGER -- ALEC PACELLA

Crystal-ball gazing on when commercial real estate's pains will end

Blog Entry: September 30, 2013 9:12 AM | Author: By Alec Pacella

Alec Pacella is a specialist in investment real estate and manages the NAI Daus brokerage in Beachwood.

Over the past few years, I have sat through many presentations on the subject of distressed real estate. And while the content has varied, nearly all had one concept in common — the widespread distressed commercial real estate environment or dilemma or opportunity should be coming to an end in 2017. It doesn't take a Mayan to figure out what is so magical about this date.

The real estate market was red-hot in the early to mid-2000s. The vast majority of the loans used by investors included maturity dates, often called “balloons,” ranging from five to 10 years. The last of the boom years, before the walls came crashing down, was 2007. So, assuming the majority of these properties were financed with mortgages that included a 10-year balloon, the last batch of these loans will be coming due in 2017.

However, I have noticed some rumblings recently that may be foreshadowing a premature end.

Tell-tale signals

First, Orix, a powerhouse in the loan servicing business, closed down its servicing division a few months ago, selling off nearly $1.5 billion of loans in the process (Crain's Cleveland Business ran a story on this subject in July). Then, last month, CIII, another powerhouse in the loan-servicing sector, closed down regional offices in Chicago and New Jersey.

Trepp, the leading provider of information and analysis for the CMBS and commercial real estate banking markets, paints a similar picture. Its widely followed Delinquency Rate Index has been steadily falling for over two years now but this has dramatically accelerated, dropping by over 200 basis points since the beginning of the year.

Finally, with vacancy rates falling and rental rates firming, real estate fundamentals have been steadily improving across all commercial property types. This has provided a much-need lifeline for many owners that have been flirting with financial disaster.

Remember: Real estate is cyclical

So what does all of this mean? Harkening on one of my favorite responses — it depends. If you are a property owner, this is likely a good thing. As the distressed market dissipates, traditional lenders will become more comfortable and the debt markets will continue to loosen. This will ultimately help to balance the market, bringing up the underlying values in the process.

However, if you are an investor, it may not be so positive. The high level of distressed assets has chronically suppressed values across all types of real estate. But a rapidly diminishing pipeline will make it much more difficult to find a “great deal.”

Real estate is cyclical and, back in the mid-2000s, we all knew that, one day, the good-time party was going to end. But few could predict that the end would be as swift and well-defined as it turned out to be.

Fast forward a decade and it is becoming increasingly apparent that the current not-so-good-time party is also coming to an end. Only time will tell how swiftly this end will occur.

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